When you visit your financial advisor, you trust their competency and ability to maintain and grow your hard-earned money. You rely on these investments to provide for your retirement, and every dollar counts when planning to live on a fixed income. But what if your financial advisor does not disclose that they collect a higher fee based on an annuity account you may not benefit most from? How do you know if annuities are a right fit for your portfolio? Here are the dirty secrets about annuities.
Background on Annuities
The annuities industry is massive with over $2.7 trillion currently under management in either fixed or variable annuities. Advisors use the selling point of tax-deferred income and guaranteed monthly income as perks of choosing an annuity, yet the profit these accounts yield is low compared to other types of investments. The truth is, brokers can earn more commission on annuities and may suggest them to investors who are not appropriate candidates for that type of account.
Lack of Transparency
Annuities are uniquely structured settlements which can be difficult to understand. Much like paying insurance every month, you pay into a fund that will ultimately re-pay you at a higher rate in the future. Since each annuity is unique, it is hard to compare their lucrativeness to other annuities.
Difficult to Understand
Annuities come in all shapes and sizes. Each annuity contract varies among provider companies and each has its own set of rules. Each annuity contract specifies the structure (variable or fixed rate), any penalties for early withdrawal, surrender period, spousal provisions such as a survivor clause, death benefit, etc. Some are in retirement plans and some are not; some have living and death benefits, others do not. Some are deferred or immediate; some are non-qualified or qualified. The complexity of the nature of annuities makes this asset very difficult to know what you’re getting – or what you have. To quote Warren Buffet, “Never Invest in a Business You Cannot Understand.”
Limited Access
Ease of accessibility can be limited, too, with some annuities remaining locked for up to 7 years. Locked assets offer no cash liquidity which could cause problems for seniors who need access to cash in the event of incurring an extraordinary expense.
Fees, Fees, Fees, and Charges
Investopedia outlines the fees that can be buried deep within an annuities contract—or not shown at all- to include:
- Commission: An annuity is basically insurance, so some salesperson gets a cut of your return or principal for selling you the policy.
- Underwriting: These fees go to those who take actuarial risk on the benefits.
- Fund management: If the annuity invests in a mutual fund, as most do, the management fees are passed on to you.
- Penalties: For early withdrawal, the IRS will get 10%, and the contract writer may ask for a surrender charge between 5% to 15%.
- Tax disadvantages: The money you earn during this period is tax-deferred. However, when you start taking distributions, not only are you taxed, but the rate is higher than for many investments. Annuity gains are taxed as ordinary income, not as long-term capital gains.
The Uniform Prudent Investment Act and a long line of cases interpreting these rules make it abundantly clear that trustees have an ongoing duty to (1) prudently administer the trust assets, (2) monitor the assets held in the trust and (3) monitor the parties who provide investment services to the trust. California Probate Code does NOT allow the purchase of annuities or insurance contracts and considers them “risky”, prohibited investments. It is fundamental to a trustee’s duties to ensure that expenses incurred by the trust are fair and reasonable. Having an annuity in trust makes that highly unlikely.
Carefully vetting your financial advisors on their compensation and potential conflicts of interest is important. Not every financial advisor will deceive the investor, and we applaud the honest advisors who listen to the individual needs of clients in order to invest in the proper type of account that suits them. For more information on how Santa Barbara Fiduciary can help ensure that your investment accounts are serving your best interests and meet the fiduciary standard, contact us today.
